Overview and Analysis of the Governor's Recommended Budget, Fiscal Year 1995–96

by Robert Kleine, Vice President and Senior Economist; Laurie Cummings, Economist; and Alec Rodney, Economist

This Advisor examines the fiscal year 1995–96 State of Michigan executive budget–Governor Engler’s spending recommendations for state government for the fiscal year that begins October 1, 1995, and ends September 30, 1996.

Introduction

The FY 1995–96 general fund/general purpose (GF/GP) budget recommendation is $8.51 billion, an increase of 4.7 percent from the current year appropriation. Adjusted for a $100.9 million appropriation to the Budget Stabilization Fund (BSF) in FY 1994–95, the budget is up 6 percent. This is the largest recommended increase since FY 198990, rather surprising given Governor Engler’s efforts to downsize state government. The increases, however, are concentrated in a few areas, with most state departments receiving modest increases or reductions.

As shown in Exhibit 1, the major budget increases are $310.4 million for health (including Medicaid), $123 million for law enforcement (mainly corrections), $75.5 million for higher education, and $56 million for regulatory (due mainly to a transfer of funds from school aid to the Michigan Jobs Commission). Substantial reductions are recommended for Social Services, $23.3 million, and school aid, $78.8 million, due mainly to program transfers.

As shown in Exhibit 2, the governor has recommended few reductions in department budgets, and most are due to program transfers and funding shifts. The largest reduction is 26.8 percent for the Department of Labor, mainly due to a funding shift to restricted fee revenue. This is also the reason for the 6.9 percent decline in the Department of Commerce budget. The 11.2 percent reduction in the Department of Management and Budget appropriation is due partly to a financing shift and partly to proposed cost reductions.

The largest increases are recommended for the Michigan Jobs Commission (315 percent), reflecting the transfer of $72 million from the school aid budget; the Department of Treasury (32 percent), due to transfer of a $12 million program from the school aid budget; the Executive Office (14.4 percent), reflecting funding for a new program; Social Services (11.3 percent), which largely covers costs increases and a funding shift for Medicaid; and State Police (9.8 percent), due to program expansions and economic (inflation) adjustments.

The total budget recommendation is $28.5 billion, only a 0.4 percent increase. This is misleading, however, as the small increase is due to a change in the method of reporting appropriations for the Department of Transportation. This year intrafund transfers are not included, reducing the reported appropriation by $716 million. Adjusted for this change, total appropriations are up 3.4 percent.

Although the GF/GP appropriation for school aid was down 11.8 percent, the total appropriation was up 3.3 percent to $8.326 billion. The increase in the GF/GP budget is explained by the 11.3 percent increase in the GF/GP portion of the Department of Social Services budget, but the total DSS budget is up only 4 percent. This difference is largely accounted for by a decline in federal aid for Medicaid, which necessitates a larger GF/GP appropriation.

Every year the budget recommendations include a number of upward and downward adjustments in program appropriations as well as program transfers and financing shifts, but as the economy and revenues have improved, the number of adjustments has declined in the past two years. These adjustments are shown in Exhibit 3.

The budget includes only $92 million in program and grant reductions and efficiencies. While this is up considerably from the FY 1994–95 budget, it is well below the level of earlier Engler budgets. Program transfers and financing shifts are also well above last year’s budget recommendations. However, much of the large reduction due to financing shifts reflects the new financing program for school aid. Excluding school aid, these adjustments are relatively modest.

The budget includes about $156 million in new program funding, largely for corrections and higher education, about the same as in FY 1994–95. Most of the increase in the budget is for new spending under current policy, about three-quarters for Social Services, mainly to cover Medicaid cost increases.

Economic and Revenue Assumptions

The governor’s FY 1995–96 budget is based on reasonable economic assumptions, although we expect growth to be a little slower than does the administration. Modest economic growth is forecast, with real (adjusted for inflation) gross domestic product (GDP) forecast to slow from 4 percent growth in 1994 to 2.9 percent in the 1995 calendar year (CY) and 1.8 percent in 1996 (CY). Motor vehicle sales are estimated to expand almost 5 percent (to 15.7 million units) in 1995 and then to fall slightly to 15.5 million units in 1996.

Last year’s budget forecast assumed that growth in Michigan would be slower than that in the United States in 1994. This was clearly in error, as Michigan did considerably better than the nation. Slower growth than the nation’s is also the assumption in this year’s budget, and the forecast may be on more solid ground this time, as the expected slowdown in auto sales will affect Michigan much more than it will the nation.

The administration projects that real Michigan personal income will increase 2.7 percent in 1995 and only 1.2 percent in 1996, down from a robust 5.4 percent in 1994. Wage and salary employment, which increased 3 percent in 1994, is forecast to rise 2.9 percent in 1995 and 1.2 percent in 1996.

As is the case almost every year, legislation and tax policy changes will affect FY 1995–96 revenue. The budget assumes one-time revenues of about $105 million, of which $81 million is from reduced revenue sharing payments to local governments. Although no new taxes are proposed, the budget recommends almost $25 million in fee increases (see Exhibit 4).

Substantial GF/GP revenue reductions are also built into the budget due to school finance reform, the 1993 cuts in the single business tax (SBT) and the income tax (pension income), and the governor’s recently proposed tax cut program, which at this writing is working its way through the legislature. School finance reform will lower revenues by $509 million, the 1993 tax cuts will reduce revenue by an estimated $161 million, and the latest tax cut proposal is expected to reduce GF/GP and school aid fund (SAF) revenues by $255 million

Adjusted for these tax policy changes, GF/GP and SAF revenues are expected to grow 6.8 percent in FY 1994–95 and 4.9 percent in FY 1995–96. These estimates are certainly achievable, although Public Sector Consultants expects revenue growth to be 0.5–1 percent slower.

Revenue Resources and Expenditure Allocations

Federal aid is the state’s largest revenue source, an estimated $7.2 billion in FY 1995–96, up 2.6 percent from FY 1994–95. State taxes and fees make up most of the remainder of funds received by the state. Exhibits 5and 6 present the own-source funding sources and expenditure allocations of the FY 1995–96 budget.

Own-source revenue excludes funds from federal, local, and private sources and is the most meaningful way to look at the budget, as it includes all revenue directly collected from the residents of the state, both earmarked (dedicated to a specific purpose) and discretionary GF/GP funds.

Exhibit 5 shows the origin of state own-source revenue. As a result of the increase in the sales tax rate from 4 percent to 6 percent, sales and use taxes have become the states largest revenue source, providing 30 percent of all own-source state revenue and surpassing the income tax, which provides 23.3 percent of revenue. The SBT (and the insurance premiums tax) is the third largest source, generating 12.2 percent of state revenue. As a result of the new school finance system, the state education property tax has become an important revenue source, accounting for 5.3 percent of state revenue.

Exhibit 6 presents the governor’s recommended distribution of own-source revenue among state programs for FY 1995–96. K–12 education is now by far the largest program, accounting for almost 41 percent of spending, due to the shift of most school district funding from the local to the state level.

The second largest budget is Social Services, 13.3 percent of spending. Included in this budget, however, is Medicaid, which is really a health program. Excluding Medicaid, the Social Services budget accounts for only 7.4 percent of state own-source spending. Health spending increased from 6.6 percent to 12.5 percent if Medicaid is included.Higher education and safety and defense (mainly corrections) both account for more than 8 percent of state spending.

FY 1995–96 Spending Policies

Following are highlights of Governor Engler’s budget recommendations for most departments and programs. The focus is on GF/GP spending, but totalrecommended spending is included in cases where federal aid and/or restricted funding is a significant factor in the department budget.

Education

Michigan schools will be fully funded in FY 1995–96. The FY 1995–95 GF/GP appropriation for school aid is $589.1 million, 11.8 percent less than the FY 1994–95 appropriation. When adjusted for transfers, however, the general fund appropriation for schools is 2 percent higher than in FY 1994–95 and the total school aid recommendation is $8,236.3 million, a 3.3 percent increase over FY 1994–95.1 The total recommendation reflects the fact that the state will receive $21.7 million less in federal aid in FY 1995–96 than in FY 1994–95.

Some of the major elements in the FY 1995–96 recommendation for school aid include the following:

The basic foundation grant will increase 3.3 percent from $5,000 per student to $5,166 per student.

To lessen the spending disparity between districts, those spending below the basic foundation grant of $5,166 will receive an increase of up to $322, twice the increase for other districts.

At-risk funding, one of the few categoricals retained under the new finance system, received $230 million, the same amount as FY 1994–95. Adult, bilingual, and vocational education will also receive the same amount as in the current year.

The special education categorical was increased $6 million from the FY 1994–95 appropriation to $191.4 million.

Separate appropriations for FICA, retirement, and technical assistance grants will not be given to intermediate school districts. They will be rolled into the general operations appropriation.

Advanced payments of $32.7 million will be paid to schools for the FY 1996–97 school year.

The FY 1995–96 recommended GF/GP appropriation for the Department of Education is $44 million, a 4.8 percent increase over FY 1994–95. It includes increases of $2.5 million to expand and improve MEAP and high school proficiency tests, $0.5 million for charter schools, and $0.8 million to provide technical assistance to schools that need help to achieve accreditation.

The governor has also proposed making unaccredited schools bear the costs of technical assistance and accreditation reviews. The school aid recommendation assumes these fees are approved by the legislature and that they will generate up to $1.7 million in FY 1995–96.

The total FY 1995–96 appropriation for the Department of Education is $764 million, a 10.2 percent increase from FY 1994–95. The increase is due to higher federal grants—$28.5 million for compensatory education, $23.9 million for the Goals 2000 school improvement initiative, and $19.2 million for school food programs.

Higher Education

After seeing their operating budgets grow at or below the rate of inflation for three years, Michigan’s universities are recommended to receive a 4.7 percent increase to $1,307.8 million in GF/GP and total funds. Each university and state and regional higher education program will receive a 3 percent increase over the FY 1994–95 appropriation.

In addition, the governor has recommended $15.6 million in one-time adjustments for Grand Valley State University, Michigan State University, and Western Michigan University. The recommended adjustments for these institutions are based on the fact that they have the lowest per-student appropriation in their Carnegie class.2

The governor has also proposed an additional $4 million for the Michigan State University animal agricultural initiative, $0.5 million for Central Michigan University’s charter school program, and an additional $0.3 million for that institution’s foreign exchange program with Japan. The governor proposed two cuts—$58,000 in dues to the Midwest Higher Education Commission and $154,500 for the Michigan Molecular Institute.

The governor has recommended that Michigan’s community colleges receive $252.1 million in FY 1995–96 GF/GP funds, a 1.7 percent increase over FY 1994–95 funds. A 3 percent overall increase is recommended to be distributed based on the Gast-Mathieu formula, resulting in increases to individual colleges ranging from 1.7 percent to 14.5 percent. The recommended appropriation for at-risk students is 3 percent higher than in FY 1994–95 for each community college.

The governor proposed to eliminate altogether state funding for Highland Park Community College (HPCC), stating that it is no longer “economically viable.” The community college budget assumes that this controversial proposal is approved by the legislature, and GF/GP funding has consequently been reduced by $6 million.

The governor has also recommended that $120.8 million in FY 1995–96 general funds be appropriated to financial aid for students, an increase of 9.7 percent. The recommended appropriation includes a 50 percent increase in funding for the Tuition Incentive Program for current and former Medicaid recipients seeking associate’s degrees or certificates. The governor has recommended limiting payments to the average Michigan community college tuition rate even if students choose to attend more expensive colleges.

While the governor maintained FY 1995–96 funding for the Indian Tuition Waiver, he proposed that the coming fiscal year be the last for this financial aid program. In explaining this controversial proposal, he stated that financial aid will still be available to Native Americans through state aid programs. Native Americans would have to meet the same need-based eligibility requirements as other financial aid applicants.

Human Services

The governor’s FY 1995–96 GF/GP recommendation for the Department of Social Services is $2,444.2 million, representing a $249.1 million (11.3 percent) increase from FY 1995 appropriations. The increase in GF/GP spending, following a slight decrease last year, reflects a significant increase in the Medicaid base and the discontinuation of special financing programs. Gross spending will increase 4 percent to $7,794.1 million.

The governor has recommended a 10 percent Medicaid base increase—including expansion of the Healthy Kids Program to cover 17-year-olds—that will cost an additional $227 million over FY 1994–95. Federal restrictions on intergovernmental Medicaid transfers will result in a net increase of $33.2 million in GF/GP spending, while increased copays and enrollment in managed care will save $10.4 million. A 12 percent decline in AFDC cases will produce $64 million in GF/GP savings.

The proposed budget for the Department of Mental Health continues the aggressive transfer of mental health services from state hospitals and institutions to community mental health (CMH) boards. The GF/GP budget will increase $27.6 million (2.7 percent) over last year’s appropriations to $1.04 billion, and gross spending will rise 6.4 percent to $1.60 billion. Highlights in the general fund budget include:

a $31.6 million transfer from state hospitals to CMH programs;

$2 million to increase the capacity of community demand services;

a $7 million economic increase for community residential care service providers; and

a $16.3 million increase for economic adjustments, including salaries at state facilities.

The governor’s FY 1995–96 GF/GP recommendation for the Department of Public Health is $187.5 million, an increase of 5.8 percent from FY 1995 appropriations. The $10.3 million increase is driven mainly by caseload and utilization increases in the children’s special health care ($11 million) and Medicaid substance abuse programs ($2.7 million). Consolidating substance abuse agencies and further movement toward managed care will produce $6.7 million in general fund savings.

Gross spending is slated to increase 4.5 percent from $632 million to $660.1 million. Much of the increase is funded by cigarette tax revenues that will be spent on child immunization, domestic violence prevention, and physical fitness programs.

HMOs are the most effective way to reduce costs because they charge the state a capitated amount—a fixed rate—for each patient regardless of the amount of medical care provided. The governor has set a goal of increasing enrollment in managed care programs from 640,000 now to over one million by the end of FY 1996.

Regulatory

The FY 1995–96 GF/GP recommendation for the Michigan Jobs Commission is $91.3 million. This 315 percent increase from the FY 1994–95 appropriation is due primarily to monies transferred from the school aid fund to the Jobs Commission for job training and Work First grants. Without this program transfer, the recommended appropriation for the Jobs Commission is 12.6 percent less than the current appropriation. The decline is due to a $2.7 million reduction in state assistance to community action agencies, a $0.8 million reduction in vocational rehabilitation grants, and $0.3 million in miscellaneous other reductions.

The recommendation includes $0.5 million for the development of skilled trade charter schools to provide high-tech vocational training to students and link them to employers before graduation. The total appropriation for the Jobs Commission is $399.8 million, a 13.5 percent increase over the FY 1994–95 appropriation. It includes $12 million in federal funds for the School-to-Work program, which helps students make the transition into the labor market.

The recommended GF/GP appropriation for the Department of Commerce is $60.3 million, a 6.9 percent decline from the FY 1994–95 appropriation. Much of the decline, however, is due to a change in the source of financing for commercial services regulation (which will be funded by license revenues) and for the homeless program (which will be funded by the Michigan State Housing Development Authority). After these two funding shifts are taken into account, the FY 1995–96 Department of Commerce recommendation is 3.7 percent higher than FY 1994–95 appropriations.

The recommended total FY 1995–96 appropriation for the Department of Commerce is $376 million, a 2.4 percent decrease from the FY 1994–95 appropriation. The decline is primarily a result of a $17.1 million reduction in federal Michigan State Housing Development Authority funds that will be redirected to local financial institutions.

The FY 1995–96 recommended GF/GP appropriation for the Department of Labor is $22.8 million, a 26.7 percent decline from the FY 1994–95 appropriation. The decline is due to proposed changes in financing for the Bureau of Worker’s Disability Compensation. Instead of using general funds, the governor has proposed an assessment on wage-loss benefits to cover the costs of administering workers’ disability. The department is recommended to receive a 3.2 percent increase after adjusting for the funding change. The total recommended appropriation for the Department of Labor is $217 million, a 3.9 percent increase from the current-year appropriation.

Safety and Defense

The Department of Corrections is recommended to receive one of the largest departmental budget increases. The recommended FY 1995–96 GF/GP appropriation for Corrections is $1,285.6 million, an increase of $98 million, or 8.3 percent. Much of the increase will be used to pay for 5,500 new prison beds, necessary in part because of longer prison sentences.

The GF/GP recommendation includes an $8 million increase in funding for parole officers and probation staff, a result in part of more early releases caused by a shortage of prison space. It also appropriates an additional $5.8 million to reimburse county jails, which are housing more and more of the state’s offenders.

The governor has also suggested some cost-cutting measures. The recommended budget includes a proposal that the eligibility requirements for boot camps be amended to permit the admission of (1) habitual offenders serving their first prison sentence and (2) prisoners who are within 36 months of their earliest release date.

The governor also recommended that judges not sentence to prison those felons who have sentences of 12 months or less. This would reserve prison space for the more dangerous offenders and cut a variety of related costs. The recommended Corrections budget has assumed that these two suggestions will pass the legislature and result in $5 million in cost savings. The total recommendation for Corrections is $1,328.2 million, an 8.1 percent increase.

The governor has recommended a GF/GP appropriation of $239.2 million for the State Police in FY 1995–96—an 11.2 percent increase after program transfers and funding shifts are accounted for. The budget maintains trooper strength at current levels and provides for a new trooper school. It provides $2.4 million to begin construction of a statewide radio network that will allow quick access to information (such as criminal records) and more efficient communications between troopers statewide. It also increases funding for the law enforcement information network, the DNA analysis program, and the automated fingerprint identification system. The recommendation reflects $12.3 million in economic increases.

The governor has also suggested that the state police collect user fees to pay for some services currently paid for out of general funds. Under the governor’s recommendation, school districts would assume the responsibility of paying for school bus inspection fees, which will generate about $0.8 million annually. Also, hospitals, nursing homes, facilities for the aged, and other high-risk care facilities would be charged for their required annual fire inspections. This is expected to raise about $2.4 million annually.

The total FY 1995–96 recommendation for the State Police is $330.3 million, a 5.1 percent increase.

The recommended appropriation for the Department of Military Affairs is $36.6 million, a 1.9 percent increase over the FY 1994–95 appropriation. The recommendation includes an additional $0.2 million for military retirement pay adjustments, $50,000 in K.I. Sawyer Air Force Base vehicle maintenance operations, and $1.1 million in economic adjustments. The recommended appropriation also reflects a reduction of $0.3 million in program efficiencies and spending adjustments. The total recommendation for Military Affairs is $83.3 million, a 0.7 percent increase from last year’s appropriation.

Natural Resources and Agriculture

The GF/GP recommendation for the Department of Natural Resources (DNR) is $96.4 million for FY 1995–96. This appropriation reflects a $4.7 million reduction from program cost savings, financing shifts, and terminations of one-time projects. The current recommended appropriation is 4.7 percent below FY 1994–95 before these transfers are taken into account and 0.1 percent above after. It reflects $1.2 million in new and expanded programs, including a new Environmental Assistance Division to assist businesses, individuals, and local governments in understanding environmental protection regulations. The governor also recommended additional funds to eliminate a backlog of wastewater disposal and permit applications.

The appropriation reflects $1.5 million in program cost savings. It continues to support the State Park Endowment Fund to improve parks and the Civilian Conservation Corps Endowment Fund to conserve natural resources, and reverses a one-time shift of monies from the general fund to the Game and Fish Fund.

The total recommended DNR appropriation of $440.9 million is 15.2 percent less in FY 1995–96 than in the previous year, primarily due to the elimination of unfunded spending authority for Michigan Underground Storage Tank Financial Assurance. Without this funding adjustment, which will not affect the program’s functioning, total funding is up 2.4 percent.

Recommended GF/GP funding for the Department of Agriculture is $46.3 million for FY 1995–96. This represents a $0.7 million, or 1.6 percent, increase from FY 1994–95. The governor recommends that $0.3 million of the increase be used to support the eradication of pseudorabies, a disease that destroys animals in the swine industry. The remaining increase is for economic adjustments to cover the cost of inflation. The GF/GP recommendation also reflects $0.6 million in program cost reductions. The total recommendation is $63.6 million, a 0.5 percent increase over FY 1994–95.

General Government

This budget category consists of six departments, the Executive (governor’s) Office, and the judicial and legislative branches of state government. The recommended GF/GP general government appropriation for FY 1995–96 is $414.1 million, 4.8 percent above FY 1994–95 appropriations. Adjusted for program transfers, the increase is only 2 percent.

The recommendation for the Department of Treasury (excluding debt service) is $57.4 million, a 32 percent increase. Most of this large increase, however, is accounted for by the transfer of $12 million for Tax Increment Finance Authority payments from the school aid fund. Excluding this transfer, the budget is up 4.4 percent. The only significant increases are $1.4 million for economic adjustments and $0.55 million for the Senior Citizen Cooperative Housing Tax Exemption program.

The FY 1995–96 recommendation for the Department of Management and Budget (DMB) is $26.2 million, an 11.2 percent decline from the current year. Not reflected, however, is funding for the Michigan Administrative Information Network (MAIN), which is carried as restricted funding ($27.9 million) in the budget but will be counted as GF spending in the department’s budget as funds are expended. Adjusted for this cost, the DMB appropriation is up 13.3 percent.

The budget has been reduced by $1.4 million due to a proposed increase in assessments against convicted defendants to pay for crime victims’ assistance. This fee increase replaces general fund monies. The major increase in the budget is $0.9 million for development of the Michigan Government Television Network.

The FY 1995–96 recommendation for the Department of State is $16.1 million, 1.9 percent above the FY 1994–95 appropriation. Adjusted for the transfer of the Vehicle Inspection/ Maintenance Program ($1.2 million) to the Department of Transportation, the budget is up 9.5 percent. The major increase is $1.4 million for economic adjustments.

The FY 1995–96 GF/GP recommendation for the Judiciary is $134.9, a 1.1 percent increase. The recommendation reflects economic increases of $3.4 million and $2.6 million in savings due to reduced workload demands on the Appellate Public Defender program as a result of voter approval of Proposal B (limiting criminal appeals). Unlike previous budgets, the recommendation allows full discretion in the use of the appropriation, no specific line items are recommended, subject to legislative oversight.

The Executive Office budget is up 14.4 percent to $5.1 million. Much of the increase is due to the addition of $0.5 million for the new Office of Regulatory Reform, the focus of which will be elimination of unneeded regulations and simplification of remaining regulations.

The FY 1995–96 GF/GP appropriation for the legislature (including the auditor general) is $97.2 million, a 2.4 percent increase. Almost all of the increase reflects economic adjustments ($2.2 million).

The recommended GF/GP budgets for the Attorney General’s Office and the Department of Civil Service are both up about 5.5–6 percent from FY 1994–95, due mainly to economic adjustments andan additional $0.6 million to the attorney general to meet critical legal services. The Department of Civil Rights appropriation is down about one percent due mainly to $0.5 millon in program efficiency savings.

Other

The Department of Transportation receives no GF/GP monies; it is funded primarily by restricted revenue, mainly gas and weight (registration) taxes and fees as well as federal aid. The recommended appropriation for FY 1995–96 is $1.78 billion, down about 1.2 percent, adjusted for elimination of interfund transfers. The budget includes an additional $44.1 million in federal aid and road and bridge construction monies and $15.9 million for anticipated debt service requirements.

The GF/GP recommendation for capital outlay is $164.5 million, up 7.4 percent or $11.3 million. Most of the increase, $10.1 million, is for State Building Authority rent requirements. Also recommended is $2.9 million for a state public safety communication system. The gross appropriation is $273.3 million, down 13 percent due mainly the transfer of Project MAIN ($15 million) to the DMB and the elimination of $29.9 million in transportation projects that were funded in the FY 1994–95 budget.

The FY 1995–96 GF/GP recommendation for debt service is $39.4 million, down $2.9 million from the current fiscal year due to the reduction of $5.4 million in debt service requirements for Water Pollution Control bonds. Partially offsetting this reduction is a $2.5 million increase for Quality of Life bonds.

The FY 1995–96 budget assumes that no withdrawals from or payment to the Budget Stabilization Fund (BSF) will be required. The Senate Fiscal Agency estimates, however, that the formula that triggers payments and withdrawals will require a $94 million payment. The balance in the BSF at the end of FY 1995–96 is estimated at about $1.025 billion, excluding a possible $175 million transfer from the monies received from the sale of the State Accident Fund. The auditor general has ruled that the sales proceeds should count as state revenue, which could require that this amount be refunded to the taxpayers, as the state is already expected to exceed the revenue limit in FY 1994–95.

Article IX, Section 30 of the state constitution requires that 41.6 percent of state spending (excluding federal aid) be allocated to local units of government, but this requirement is now academic because of school finance reform. In FY 1995–96 state payments to local units of government (which includes school districts) are estimated at 59 percent of state spending. This removes the protection local governments had against sharp reductions in state support, although no such reductions are anticipated in the near future.

Cuts in federal aid to Michigan as a result of the proposed balanced budget amendment to the Constitution or other actions to reduce or eliminate the federal budget deficit could result in sharp cuts in state support to local governments.

Article IX, Section 26 (state tax limit) of the state constitution restricts the amount of money the state may collect in any fiscal year to 9.49 percent of Michigan personal income. The limit for FY 1995–96 is an estimated $19.8 billion (PSC estimate). Estimated revenues are about $0.6 billion below the limit. This assumes a reduction in tax revenues of about $250 million as a result of the governor’s proposed tax cut program, which is intended to keep revenues in FY 1994–95 from exceeding the tax limit as well as to provide permanent tax relief. The current consensus revenue estimate (administration and House and Senate Fiscal agencies) is that without a cut in taxes, FY 1994–95 revenue will exceed the tax limit by about $300 million (the PSC estimate is $265 million).

Comment

At first glance the FY 1995–96 budget appears to be quite generous, as it is up 6 percent from FY 1994–95 (adjusted for FY 1994–95 BSF transfer). If Medicaid and Corrections are excluded, however, the remainder of the budget is up only 1.9 percent, or $113 million, with $73 million or 65 percent of the increase allocated to higher education. This is well below the projected inflation rate of 3.2 percent.

Although the FY 1995–96 budget is based on reasonable economic assumptions, a shortfall in revenue growth of as little as one percent in FY 1994–95 and FY 1995–96 could throw the budget out of balance. Our projections show a potential budget deficit of about $100 million in FY 1994-95 (most of which could be covered by budget lapses), and $250 million in FY 1995–96.

This is a very manageable problem, particularly in view of the expected BSF balance of over one billion dollars. Our concern is that the tax cuts of the last two years, which total about one billion dollars and have made the tax structure more unstable, leave the budget vulnerable to an economic downturn.

If revenue growth is flat in FY 1995–96, the GF/GP budget will be in deficit by about $0.6 billion (assuming an additional $300 million payment to make up the shortfall in the school aid fund). If there is also no revenue growth in FY 1996–97 and expenditures increase at about the rate of inflation (3.5 percent), the budget will be about of balance by about one billion dollars. Without sharp budget cuts, the balance in the BSF would be quickly depleted.

Our view is that it would be unwise to cut taxes any more than proposed by the governor. To do so risks serious near term fiscal problems. In fact, the recent changes in the tax system make the state budget more vulnerable to economic downturns, making fiscal prudence, including maintenance of large balances in the BSF, even more important. Adding to future uncertainty is the possibility of large cuts in federal aid as the federal government struggles to reduce the nation’s budget deficit.

1These Adjustments include a $72 million transfer of job training and EDGE grants to the Michigan Jobs Commissioned and a $22 million transfer of Tax Increment Financing Authority (TIFA) payments to the Treasury Department.2The “Carnegie class” is the Carnegie Foundation categorization of universities based on their academic mission. Grand Valley State University is a “master’s” institution, Michigan State University is a “research” institution, and Western Michigan University is a “doctoral” university.